In the News

SEC action on European research rule brought 'sigh of relief' to banks, brokers

November 3, 2017

A sweeping European market-reform initiative was poised to disrupt U.S. brokers' equity research businesses until Wall Street's chief regulator entered the fray.

Europe's revised Markets in Financial Instruments Directive, or MiFID II, was designed to level the playing field among financial services companies through a myriad of regulatory changes, most prominently the separation of research costs from trading execution costs.

But for a U.S. broker to receive direct payment for research, the Securities and Exchange Commission requires the broker to register as an investment adviser under the Investment Advisers Act, which can add regulatory costs and fiduciary duties to the firm. The prospect of operating under MiFID II put many global broker/dealers and investment banks at a crux between U.S. and European regulation.

The unbundling of research costs from other fees clients pay "is the most potentially disruptive [MiFID II change] and has the potential to upset business models quite a bit," Spencer Mindlin, an analyst with research and advisory company Aite Group, said in an interview. "[The SEC] had no choice but to put something in place to make it easier for firms to comply."

The SEC sent a series of no-action letters on Oct. 26 to prevent the need for U.S. companies to overhaul their research divisions under MiFID II. The decision came just over two months before the mandate's Jan. 3, 2018, rollout and was preceded by months of companies raising concerns over the European initiative.

In the letters, the SEC said that for 2.5 years, it would not penalize companies not registered as investment advisers for unbundling the costs of research and trading, as long as the clients and assets fall under MiFID II requirements.

"This was needed by the industry to continue to operate business as usual," said Joe Gawronski, president of research and brokerage company Rosenblatt Securities, in an interview. Gawronski said the SEC's letters brought a "sigh of relief" for the industry.

The expected changes to research payments under MiFID II drove some institutions, notably Bank of America Merrill Lynch, to file to become a registered investment adviser with the SEC. A report of the company's decision to become an RIA came just a day ahead of the SEC's letters eliminating the need to do so.

The SEC's new guidance was viewed as a win for many brokers and banks, including members of the Securities Industry and Financial Markets Association, which had pressed the regulator for relief in various comment letters.

"Preserving the ability of U.S. broker/dealers to provide research to their EU clients without being subject to the Advisers Act is critical in maintaining the competitiveness and efficiency of the U.S. capital markets," SIFMA said in a statement.

But the relief has an expiration date, and not all market participants welcomed the SEC's action. SEC Commissioner Kara Stein said in a statement that the agency's relief "merely kicks the can down the road," and that larger issues over transparency and investor protection are still looming in U.S. markets.

For several months, trade group Healthy Markets Association has lobbied the commission in support of the unbundling rule to allow investment advisers to freely shop for research and execution services with separate, transparent pricing.

"With any kind of luck, the market forces are going to undo some of the damage that the SEC staff just did," said Tyler Gellasch, executive director of the Healthy Markets Association, in an interview. "We are on the edge of moving into a very, very different world for payment of research, and no matter what the SEC did, it was moving that way."

The Healthy Markets Association consists of member pension funds and asset managers such as California Public Employees' Retirement System, Janus Capital Management LLC and OppenheimerFunds Inc.

Eventually, the SEC's relief will likely become the law of the land in the U.S., Aite's Mindlin said. But even if made permanent, the relief is not expected to solve all of MiFID II's issues related to research, as many brokers' clients are re-evaluating how they use and pay for research, said Evercore Inc. President and CEO Ralph Schlosstein during a recent third-quarter earnings conference call.

"It is likely that the effect of MiFID II will be to reduce the research spend of our clients, not just in Europe but globally," he said.